Statement on Monetary Policy – November 2008 Price and Wage Developments

Recent developments in inflation

The CPI data for the September quarter showed that inflation remained high, with the CPI increasing by 1.2 per cent in the quarter and by 5.0 per cent over the year (Table 12, Graph 78). However, inflation appears to have levelled out in quarterly terms, with a range of measures suggesting that underlying inflation was around 1.2 per cent for the third consecutive quarter. In year-ended terms, underlying inflation looks to have been a little over 4½ per cent in the September quarter.

Price pressures continued to be relatively broad-based, with over 70 per cent of items in the CPI (by expenditure weight) growing at an annualised rate of more than 2.5 per cent in the September quarter (Graph 79). Large contributions to the quarterly outcome came from housing, a wide range of food items, travel, petrol and financial & insurance services. These were only partly offset by falls in the cost of child care (due to an increase in the child care rebate), pharmaceuticals and a range of consumer discretionary items.

Non-tradables inflation continued at a fast pace, at 1.6 per cent in the quarter and 6.1 per cent over the year (Graph 80). The main contributor was housing, with the various components all rising strongly in the quarter: rents rose by 2.1 per cent (and by 8.2 per cent over the year), reflecting low rental vacancy rates; house purchase costs increased by 1.3 per cent, as rising materials costs added to price pressures; and utilities recorded very large rises to be 10.8 per cent higher over the year, with a particularly large rise in water and sewerage prices. The cost of deposit & loan facilities also continued to grow strongly, and most other services components of the CPI recorded above-average increases.

Tradables inflation was 0.7 per cent in the September quarter and 3.4 per cent over the year. Fuel prices made the largest contribution to this group, rising by 2.0 per cent in the quarter and by 25 per cent over the year. Food prices rose by 1.4 per cent in the quarter to be 3.4 per cent higher over the year. Excluding food and fuel, tradables inflation remained modest at 1.1 per cent over the year, but continued to show signs of an upward trend. Given the recent sharp depreciation in the Australian dollar, tradables inflation is likely to pick up significantly in coming quarters as higher import prices gradually flow through into retail prices.

Costs and margins

Growth in labour costs remains at elevated levels, reflecting recent tightness in the labour market, but continues to show little sign of acceleration. The wage price index (WPI) rose by 1.2 per cent in the June quarter, with year-ended growth remaining firm at 4.2 per cent (Graph 81). Growth in the private-sector component of the WPI has been higher, with delays in renegotiating several public-sector collective agreements contributing to slightly softer outcomes in the public-sector component: growth in the latter is likely to pick up somewhat as these new agreements flow through. At the state level, Western Australia continued to record substantially stronger wage growth than the other states, with the WPI rising by 5.6 per cent over the year.

Other measures of wage growth have provided a somewhat mixed picture of growth in labour costs. The national accounts measure of average earnings, which is conceptually the broadest measure of earnings but very volatile, rose by 1.8 per cent in the June quarter to be 4.0 per cent higher over the year. The average annualised increase for new federal enterprise bargaining agreements formalised in the June quarter was also 4.0 per cent, which is in line with the average since 2003. However, measures from the average weekly earnings survey moderated slightly in the June quarter, with growth in ordinary-time earnings recorded at 0.7 per cent in the quarter and 3.7 per cent over the year. Broader measures of labour costs from business surveys show that wage pressures remained stable at above-average levels.

Producer price data suggest that upstream price pressures intensified in the September quarter and that this was broad-based across categories. Persistent strength in domestic goods inflation was accompanied by a turnaround in import prices reflecting the depreciation of the exchange rate (Graph 82). All stages of production recorded their largest quarterly and year-ended increases in the ten-year history of the series. At the preliminary stage, prices rose by 5.5 per cent in the quarter (or by 3.7 per cent after abstracting from a trebling in coal prices flowing from the earlier increase in export contract prices) and 13 per cent over the year: while resource-related prices increased sharply (and were yet to show any signs of moderation from recent falls in spot commodity prices on global markets), non-resource price inflation also picked up further. At the final stage, prices rose by 2.0 per cent in the quarter and by 5.6 per cent over the year, with most items posting sizeable rises.

At the industry level, all sectors recorded strong increases in prices. Construction sector prices rose by 1.8 per cent in the quarter and by almost 7 per cent over the year as firms passed on part of earlier sharp increases in raw material costs (particularly steel). Manufacturing prices (excluding oil) rose by almost 6 per cent over the year, with metals, chemicals, food and a range of other goods all contributing. Property & business services prices were up by 6 per cent over the year and transport & storage prices increased by nearly 8 per cent.

While rising input costs have contributed significantly to higher producer and consumer inflation in recent years, a slowing in medium-term productivity growth may also have been a factor. Since 2000, trend multifactor productivity in the market sector has grown by only 0.6 per cent per year, compared with 1.8 per cent over the 1990s (Graph 83). The combination of steep rises in input costs and weaker productivity growth implies that growth in business costs per unit of output has picked up in recent years.

Recent data on business margins have provided mixed signals. Estimates based on ABS profits data suggest that margins in both the broader economy and the goods distribution sector – which includes retail & wholesale trade and transport – were stable in the June quarter at above-average levels (Graph 84). In contrast, data for the September quarter from the NAB survey suggest that margins fell in the June and September quarters.

Inflation expectations

Indicators of inflation expectations remain elevated, although there has been some evidence of moderation in recent months. According to the Melbourne Institute survey of households, the median expectation for CPI inflation over the year ahead was 4.4 per cent in October, down from the mid-year peak of nearly 6 per cent (Graph 85). Medium-term inflation expectations implied by indexed bond yields and inflation swaps have also declined noticeably, to be around 2½ per cent. However, the limited liquidity of these markets makes it difficult to infer too much from derived series for inflation expectations.

Market economists surveyed by the Bank following the release of the September quarter CPI continue to expect above-average inflation in the near term, although medium-term expectations have eased. The median expectation for headline inflation over the year to the June quarter 2009 is now 3.4 per cent, compared with 3.3 per cent in August (Table 13). Over the year to the June quarter 2010, the median inflation expectation is 2.6 per cent, down from 2.8 per cent in August. Surveys of both businesses and union officials generally suggest that inflation expectations remain elevated.